Montage of bitcoins and other crypto currencies
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Good morning. Treasury yields continued to fall yesterday, sending a dreary and increasingly familiar message about growth in the months to come. But headlines were dominated by crypto. A few words on that, and on rent inflation, below. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Why Tether snapped

A sudden and brief collapse in the price of the stablecoin Tether — coming just as virtually every other cryptocurrency sold off hard — gave everyone a bit of a heart attack yesterday:

Line chart of $ per token showing Tether loses its $1 peg

A Tether wobble is so worrisome because it is — theoretically — pegged one-to-one to the dollar by a bundle of fiat assets. Like a country defending its currency from depreciation, the issuer company (Tether Limited) can buy Tether tokens with fiat money to prop up the token price.

The peg has frayed before, though. During the 2018 “crypto winter”, tether traded as low as 91 cents for several days. But it recovered, and the episode helped solidify faith that while crypto is volatile, it is resilient and ultimately trends up. Crypto enthusiasts have been reassuring everyone that this latest sell-off is a repeat of 2018.

Yet Tether Limited refuses to fully disclose the fiat assets it holds, so it is impossible to gauge the resilience of the peg. Regulators worry about a wave of mass redemptions on Tether and its peers — an old-fashioned bank run. A run on Tether would be particularly dangerous because it is fundamental to overall crypto market liquidity. It is the primary medium for moving back and forth between crypto assets and dollars. Its failure could bring the whole crypto ecosystem to its knees. As one of the founders of dogecoin put it, “If Tether dies, it’s all over, friends.”

The worries were amplified by the fact that another cryptocurrency, TerraUSD, also melted down this week. While TerraUSD also calls itself a stablecoin, it has little in common with Tether besides the goal of being worth $1. Instead of being backed by dollar assets, it is an “algorithmic stablecoin”. Here is how its peg — if you want to call it that — works:

  • Terra has a counterpart cryptocurrency called Luna.

  • A system of smart contracts lets traders exchange $1 worth of Luna (at market prices) for a single Terra token, or a single Terra token for $1 worth of Luna.

  • Arbitrage kicks in.

  • If Terra is overvalued at $2, you buy one Luna for $1, exchange for one Terra, and sell your Terra for $2.

  • If Terra is undervalued at 50 cents, you buy one Terra for 50 cents, exchange for $1 worth of Luna, and sell your Luna for $1.

  • Therefore if there is enough buying and selling, Terra should stay near $1.

This seems like a house of cards because it is. The system relies on an active market, which in turn requires traders to believe they won’t get stuck holding the bag. If everyone sours on TerraUSD at once, the whole thing crumbles. The fragility of this system has long been obvious to close crypto watchers. Here’s Nevin Freeman, co-founder of the stablecoin Reserve, predicting exactly what has just happened back in 2020:

I think that the biggest risk [for] stablecoins is if there’s an algorithmic stablecoin that has no backing, that just has an algorithmic mechanism that’s meant to keep it stable . . . . One of those could launch and be marketed very effectively and be significantly adopted . . . . If that protocol then blows up economically, and the price goes down half or close to zero, [you could have] regulatory backlash.

Yesterday, bad sentiment from the TerraUSD fiasco led to selling pressure in Tether, even though the underlying mechanisms are very different. So far, Tether has defended its peg. But the whole mess has focused attention on the spillover effects for traditional markets. Yesterday, there was speculation that a crypto collapse could wreck retail investor sentiment, lead to a stampede out of equities, spark a rally in safe haven assets such as Treasuries or destabilise short-term funding markets.

We do not know what is going to happen, but the danger cannot be dismissed out of hand. Stablecoins have a total market capitalisation of more than $150bn. If the pegs all break — and they could — there will be ripples well beyond crypto. (Ethan Wu)

Housing, inflation and the Fed

A refrain commonly heard in the Wall Street commentariat in recent weeks is that the Fed won’t be able to get inflation under control if it cannot get house prices and rents under control first.

In a sense, this is tautologically true: rent and owners’ equivalent rent (OER) are more than 30 per cent of CPI inflation and 40 per cent of core CPI inflation. If those two are locked into a rapid rise, the Fed is fighting a losing battle.

It is also true that CPI measures lag behind private-sector rent indices, for the simple reason that the private sector measures only look at spot rent increases (the increase that occurs when a tenant signs a new lease on a property). But rent usually increases annually or even more irregularly, and the CPI measures look at a mix of new and existing leases, creating a lag. Recent academic work puts the lag at 16 months or so. So the rent inflation we are seeing now in the real world — 17 per cent year over year, according to Zillow — is going to show up in CPI inflation 2023 and 2024 (more here).

It is also true that house prices are still rising fast (20 per cent or so, though the data is a bit stale) and generally speaking, rent increases follow house price increases. Finally, because housing supply is so tight in the US, the higher mortgage rates we are seeing now might only slow, but not stop, further home price increases. So it may look as if we are locked into abnormally high rates of inflation in the months and years to come, and there is little the Fed can do.

But the picture might not be quite so bleak. Two points in particular are worth noting.

The first point is simple and methodological. Owners’ equivalent rent does not have any direct link to house prices. It is not, as is sometimes thought, arrived at by asking homeowners what they would charge to rent their house out. It is based instead on surveys of actual rents of similar properties.

The second thing to realise is that the primary way the Fed can bring rents down is not by raising mortgage rates to bring house prices down, and thus bringing rents down. Most people do not regularly borrow money to pay rent. Rent money comes from wages. The Fed’s ability to change the cost of borrowing does not, therefore, directly impact rents.

But it does influence it indirectly. When the Fed tightens financial conditions, companies spend less, including on wages. And this explains why rents correlate more immediately and closely with wages than house prices. Here is a chart from Skanda Amarnath at Employ America, plotting CPI rent and OER against a broad measure of wage growth:

The punchline here is that if the Fed can get wages under control, it can probably get rent and OER under control, too. Yes, there will be a lag in time, but persistent house price inflation and the tightness of housing supply should not prevent the Fed from getting overall inflation under control — provided it can damp aggregate demand and therefore wages. As Amarnath said, to get shelter costs under control, all we need is slower job growth, slower wage growth and time.

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